Palestine or How the Market fails without a State Heiner Flassbeck

Palestine is economically extremely dependent on Israel. Reducing this dependency must be the ultimate goal of the political effort to implement a two-state solution. However, in order for the Palestinian government to use its political power for the good, it is essential to understand the proper role of the state in the development process.

Last week, I spent four days in Palestine. I was invited by the Palestine Economic Policy Research Institute (MAS) to deliver the ninth annual development lecture in memory of a pioneer of Palestinian political economy, Prof. Yusif Sayigh. The series aims at prompting a critical, heterodox debate about globalization, economic development and alternative economic policy concepts. It was my first visit to Ramallah, Jerusalem and Jericho. The visit proved to be a fascinating experience to gain insights into this fragmented and divided land that is to a large degree governed from the outside, by an Israeli occupation force that has been in place for fifty years and by the OECD level Israeli economy that powers it.

The Palestinian Authority, the Palestinian self-government in the Occupied territories since 1994 is facing unimaginably big problems, mainly rooted in occupation and lack of sovereign policy space.. Its task is to govern, service and develop a region that is both geographically and administratively divided into many different parts. Additionally, it does not have the full executive functions of a proper state.

Palestine is extremely dependent on the economic conditions in Israel and on Israeli economic and monetary policies. It has a very high current account deficit with its big neighbour and it is dependent on the economic policies of Israel and many people search employment in Israel. Israel, from it part, organises strict security (both internally and externally), unevenly distributes crucial resources such as water, land and energy. Its currency, the Skekel, is used for most transactions in the West Bank and Gaza Strip, and under the prevailing policy agreements, the Palestinian Authority cannot issue a currency or undertake independent macroeconomic policy management

A currency for Palestine?

So far, the attempts of the government in Ramallah to free themselves from this grip have had little success. The current Monetary Authority plans to rename itself and become a central bank in the near future. It has intentions to introduce its own currency in a later phase. But this does not alter the fact that the country’s economic base is currently very weak and a path to an accumulation of a stock of capital that would factually underpin a strong and stable currency is very far off. In addition, there is the chronic and major difficulty of stabilising an exchange rate of any small open country as long as the world relies on floating exchange rates.

Palestine is, in effect, an exemplary case of what happens if one allows a market economy without having a functioning state in place and without a functioning credit system. The country eventually becomes what a Palestinian colleague quite openly described to me as a “coffee shop and a take away economy.” There is, without a doubt, a lot of potential. A lot of initiatives are being taken, but, crucially, the efforts remain uncoordinated and there is no public infrastructure, which would allow integrating the private efforts into a coherent development strategy.

Is free individual activity and enterprise the solution?

As said, there is a lot of individual economic enterprise activity, but, given the prevailing difficult circumstances, it remains limited to what any individual or single firm can do. This does not detract from the fact that many are capable of reaching a standard of living that is well above the poverty line. There is, however, no industrial manufacturing infrastructure that would produce long-term and significant productivity gains. Without such productivity gains, it is simply impossible to catch up with the powerful neighbour, who obviously has the advantage of a well-functioning state that implements well-coordinated economic policies.

In developing countries, productivity gains are realised primarily by copying western technology or by bringing western companies with very advanced technology into the country. None of this happens if there is no functioning state that participates directly in the financing and the implementation of such projects or offers foreign investors particularly good conditions. For both forms of rapid industrial development, the Asian experience has been relevant. Examples are Japan and South-Korea (where the state directly intervened), and China (where mainly foreign investors provided the know-how).

The Palestinian economy’speculiar circumstances become all the more clear when one drives through the country and has a look at the agricultural sector. Many farmers grow fruit and vegetables on small patches of land and are doing relatively well. But modern agriculture, which could lead to big productivity gains, is largely absent. This is not a shortcoming of the farmers, it is clearly attributable to the lack of a comprehensive agricultural policy that would help farmers overcome modest productivity thresholds.  The fact is that no Western country has made the leap from small-scale farming to modern agriculture without an active agricultural policy. The formulation of such a policy remains impossible in Palestine, because the country is dependent on Israel for its water supply and Israel directly controls some 60% of the territory of the prospective Palestinian state, much of it comprising the most valuable agricultural and natural resource zones . The Palestinian areas are structurally disadvantaged, sometimes to an incredible degree. But it must be said: even without these extreme problems, the Palestinian authorities seem politically inclined to leave agricultural supply to individual efforts or to buy abroad.

There is money, but it is sporadic and unorganised

Certainly, a lot of capital flows in from many sources to the West Bank part of the Palestinian economy. The problem is that the positive overall effects remain distinctively lower than what could be possible because, almost always, only individual projects are being promoted. They form a large unstructured patchwork, which is supposed to drive the country forwards, given the absence of a real state. A new university in the area which has been funded by several Arab sources, will do only limited good if there is no transport infrastructure that links it to the city and the surrounding region. One wonders where many of the university graduates will find a job in the domestic economy when most of the companies remain small family businesses.

In addition, in Palestine, as unfortunately in most other developing countries, scientific institutions teach neoliberal economics, emphasising individual initiatives and „solutions,“ promising that the sum of all these individual actions will result in successful development. The fact that, in my lectures in Palestine, I emphasized the role of the state and showed that many of the hoped-for market-based “solutions” exist only in the imagination of the neoliberals, has sometimes amazed my hosts. The same is true for the labour market. Apart from a minimum wage (the compliance of which is difficult to control), the Palestinian authorities have hardly developed any concrete ideas about wages and productivity. And the same applies to the conundrum of interest and savings. Here, also, most of the neoclassical ideas have been uncritically accepted.

Capital does not flow, it is being generated

The biggest difficulty lies in understanding the role of capital. This production factor is not, as neoclassical theory takes for granted, in any way predetermined (and scarce in developing countries): it is generated in each country within the context of the economic process. Developing countries have been pushed for decades to either import capital (hence, allowing current account deficits) or to ensure that their citizens are capable of saving. The latter led to the absurd view, that some still believe, that generating a sufficient amount of wealthy people is a prerequisite for independent and successful economic policies to occur in the future.

This is, of course, complete nonsense, but it is very persistant. Many obstinately refuse to understand – even though the Asian countries have proved it – that even developing countries can have current account surpluses during their catching-up process and huge investment cycles, even though households do not save one percentage point more of their income. If a country succeeds in initiating a process in which the demand of private households increases, companies will always invest more (the investment will be financed directly by the central bank and bankers’ money creation) and capital in the form of higher incomes will emerge. Such genuine economic development can take place even in a country that was destitute in the beginning.

New insights and new politics

There can be no doubt that Palestine needs more political capacity. Without a political normalisation of the relations with Israel as part of an effective and equitable two-state solution, Palestine will never be able to catch up and normalise its economic policies, that is say, to reduce its over-reliance on Israel. In addition to overcoming all these political obstacles, however, the emancipation of the government and the intellectuals from wrong economic policy ideas is also paramount. Only those who have some correct notions of economic development will be politically successful if given the opportunity. The international community should continue to work in order to provide the government in Palestine with the political power that any real state has. But the Palestinians will only be able to use these opportunities if they understand how economic development comes about.

(Prof. Heiner Flassbeck , Hamburg University and Former Director of Globalisation and Development Strategies, UNCTAD.)